Business context and reporting period
Realty Income Corporation, a REIT focused on long-term, predominantly single-tenant net-leased commercial properties, filed this unaudited Form 10-Q for the quarter ended September 30, 2012. At quarter-end it owned 2,838 properties in 49 states, with 97.0% occupancy, 34.3 million leasable square feet and an approximately 11-year weighted-average remaining lease term on leased single-tenant properties.
Financial results and key metrics
Amounts below are in millions except per-share data; nine-month cash flows are for the period ended September 30.
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Total revenue | $120.2 | $106.2 | $349.9 | $303.5 |
| Net income | $37.5 | $40.8 | $120.1 | $116.0 |
| Net income available to common stockholders | $27.0 | $34.7 | $86.0 | $97.8 |
| Diluted net income per common share | $0.20 | $0.27 | $0.65 | $0.79 |
| Diluted FFO per share (non-GAAP) | $0.48 | $0.50 | $1.42 | $1.46 |
| Diluted normalized FFO per share (non-GAAP) | $0.52 | $0.50 | $1.47 | $1.46 |
| Diluted AFFO per share (non-GAAP) | $0.52 | $0.51 | $1.52 | $1.49 |
- Revenue and operating trends: Rental revenue rose 13.3% in Q3 and 15.2% for 9M. Growth was driven largely by acquired properties; same-store rents declined 1.0% in Q3 and 0.8% for 9M. Excluding leases with Friendly’s and Buffets, same-store rents increased 1.0% and 1.1%, respectively.
- Expenses and earnings: Q3 depreciation and amortization was $37.8 million and interest expense $29.7 million; for 9M, they were $108.3 million and $87.5 million. Higher depreciation, interest and G&A, together with $5.5 million of merger costs in 2012, contributed to lower GAAP earnings available to common holders. Nine-month results also included a $3.7 million preferred-share redemption charge.
- Cash flow: 9M operating cash flow was $208.5 million, versus $199.2 million in 2011. Investing used $625.6 million, primarily for property acquisitions and improvements; financing provided $415.7 million. Cash declined $1.4 million to $2.8 million.
- Balance sheet and debt: At September 30, total assets were $5.04 billion, total liabilities $2.59 billion and stockholders’ equity $2.44 billion. Debt comprised $609.0 million drawn on the credit facility, $133.4 million mortgages and $1.75 billion notes and bonds. Facility availability was $391.0 million. Management reported covenant compliance; total borrowings were about 29.1% of market capitalization. October note proceeds subsequently repaid the full facility balance.
- Distributions: Common distributions paid in 9M totaled $175.7 million, versus AFFO of $201.3 million; the company reported a 87.3% payout ratio on that basis. The monthly common dividend rose to $0.1514375 in October, equivalent to an annualized $1.81725 per share. Management cautioned that future dividends and increases are not assured.
Material changes and management commentary
- During 9M 2012, Realty Income invested $717.6 million in 234 properties and properties under development, versus $826.4 million in 125 properties in 9M 2011. The 2012 investments were 100% leased, with a 7.1% initial weighted-average contractual lease rate and a 14.3-year average lease term.
- On September 6, the company agreed to acquire American Realty Capital Trust (ARCT) in a stock-for-stock transaction valued at approximately $2.95 billion, expected to add about 500 properties. Closing was subject to shareholder approval and expected in Q4 2012 or early Q1 2013; completion was not assured. Realty Income reported $5.5 million of incurred merger costs and estimated total transaction costs of approximately $30.7 million.
- Management anticipated approximately $1.0 billion of property acquisitions during 2012 and announced agreements in October for another approximately $283 million of properties. It also planned more active dispositions, estimating $25–$75 million of proceeds over the next 12 months, subject to available sales and reinvestment opportunities.
- In October, the company issued $350 million of 2.00% notes due 2018 and $450 million of 3.25% notes due 2022; net proceeds of approximately $790.7 million were used to repay facility borrowings, with the balance for general corporate purposes.
Outlook, risks and unusual items
- Eight lawsuits had been filed by October 18 in connection with the proposed ARCT transaction, seeking to enjoin or rescind it and alleging fiduciary-duty breaches and related claims. Realty Income said it considered the actions without merit. The merger also presents approval, integration, execution, expense and potential dilution risks.
- Friendly’s and Buffets emerged from bankruptcy in 2012. Management estimated recovery of approximately 80% of Friendly’s former $16.1 million annual rent and 65% of Buffets’ former $18.2 million annual rent.
- The company identified exposure to tenant defaults, economic and real estate market conditions, interest rates, access to capital, property impairments, REIT qualification, and environmental and other real estate risks. A 1% rate change on the quarter-end credit-facility balance would change annual interest cost by approximately $6.1 million. Moody’s outlook was negative; Fitch and S&P outlooks were stable.
- Q3 and 9M results included $667,000 of property impairments in discontinued operations. Seven properties were classified as held for sale at quarter-end. Management stated that the company remained current on Class E and F preferred dividends and was in compliance with debt covenants.
Important facts for investors to verify
- Whether ARCT received shareholder approval, the final closing terms and timing, total transaction costs, and any merger-related litigation or integration effects.
- Whether acquisitions close as planned and generate expected rent; assess acquisition yields alongside funding costs and the impact of new common or preferred shares.
- Tenant rent collections and leasing progress, particularly Friendly’s and Buffets, the 84 vacant properties, and the negative same-store rent trend.
- Dividend coverage and cash available after preferred dividends, property investment, debt service and recurring capital needs; FFO, normalized FFO and AFFO are non-GAAP measures and not substitutes for cash flow.
- Debt maturities, interest-rate exposure, rating outlooks and covenant headroom, including the effect of subsequent debt issuance and repayment of the credit facility.